Agency theory describes the relationship between principals (owners) and agents (managers) in a company. There is potential for conflict since the owners delegate decision-making authority to managers. This can lead to agency problems and costs if the managers' interests are not aligned with the owners' interests. Agency problems occur due to issues like moral hazard, adverse selection, and managers potentially pursuing their own interests over maximizing shareholder value. Solutions to the agency problem include structuring executive compensation contracts and plans to better align the interests of owners and managers.

1. AGENCY THEORY
-Presented to
Prof. Ashwin Solanki
-Prepared by
Bhatt Bhoomika

2. “Definition”
“A contract under which one or more persons (the
principal(s)) engage another person (the agent) to
perform some service on their behalf which involves
delegating some decision making authority to the agent.”
(1976, p.308)

3. 3
Concepts of Agency Theory
Involves separation of owners (principals)
and managers (agents) of a firm
• Potential exists for owners’ wishes to be ignored
Involves delegation of decision-making
authority by owners to managers
Potential agency costs can include
• Agency problems
• Actions taken to minimize agency problems

4.  Goal Orientation
 Obligation and
Reciprocity
 Risk
 Self-Interest
Agent
Conflict
Congruence
Principal
Agency Theory Diagram

5. 5
How Can Agency Problems Occur?
Moral hazard problem
• Owners have access to limited information
• Owners cannot monitor every executive decision
• Executives often free to pursue own interests
Adverse selection
• Stockholders have limited ability to determine
competencies of executives at time of hire
• Problems of overlapping priorities between owners
and executives likely to occur

6. 6
Potential Agency Relationship Problems
1. Executives pursue growth in company size
rather than in earnings
2. Executives attempt to diversify their
corporate risk
3. Executives avoid risk
4. Managers act to optimize their personal
payoffs
5. Executives act to protect their status

7. 7
Solutions to the Agency Problem
Define agent’s responsibilities in a contract,
including elements like bonuses to align
executives’ and owners’ interests
Pay executives a premium for their services
Structure a backloaded compensation plan
for executives
Create teams of executives across different
organizational units to focus on overall
organizational performance